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Economics
- the study of the ALLOCATION of SCARCE resources to meet UNLIMITED human wants.

It is the study of human behavior. Since it uses scientific methods it is called a social science. We
study human behavior to better understand and improve our world.

Economics evolves continuously as current observations and experience provide new evidence
about economic behavior and relationships. Inference and policy recommendations based on
earlier theories, observations and institutional structures require constant analysis and updating if
they are to furnish valuable responses to changing conditions and problems.

All choices mean that one alternative is selected over another. Selecting among alternatives
involves three ideas central to economics: scarcity, choice, and opportunity cost.

a. Scarcity

Our resources are limited. At any one time, we have only so much land, so many factories, so
much oil, so many people. But our wants, our desires for the things that we can produce with those
resources, are unlimited. We would always like more and better housing, more and better
education— more and better of practically everything. If our resources were also unlimited, we
could say yes to each of our wants—and there would be no economics. Because our resources
are limited, we cannot say yes to everything. To say yes to one thing requires that we say no to
another. Whether we like it or not, we must make choices.

Our unlimited wants are continually colliding with the limits of our resources, forcing us to pick some
activities and to reject others. Scarcity is the condition of having to choose among alternatives. A
scarce good is one for which the choice of one alternative requires that another be given up.

Scarcity and the Fundamental Economic Questions

The choices we confront as a result of scarcity raise three sets of issues. Every economy must
answer the following questions:

1. What should be produced? Using the economy’s scarce resources to produce one thing
requires giving up another. Producing better education, for example, may require cutting back
on other services, such as health care. A decision to preserve a wilderness area requires giving up
other uses of the land. Every society must decide what it will produce with its scarce resources.

2. How should goods and services be produced? There are all sorts of choices to be made in
determining how goods and services should be produced. Should a firm employ a few skilled or
a lot of unskilled workers? Should it produce in its own country or should it use foreign plants?
Should manufacturing firms use new or recycled raw materials to make their products?

3. For whom should goods and services be produced? If a good or service is produced, a decision
must be made about who will get it. A decision to have one person or group receive a good or
service usually means it will not be available to someone else.

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 MT. CARMEL COLLEGE OF SAN FRANCISCO, INC.
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b. Opportunity Cost

It is within the context of scarcity that economists define what is perhaps the most important
concept in all of economics, the concept of opportunity cost. Opportunity cost is the value of the
best alternative forgone in making any choice.

The opportunity cost to you of reading the remainder of this chapter will be the value of the best
other use to which you could have put your time. If you choose to spend $20 on a potted plant,
you have simultaneously chosen to give up the benefits of spending the $20 on pizzas or a
paperback book or a night at the movies. If the book is the most valuable of those alternatives,
then the opportunity cost of the plant is the value of the enjoyment you otherwise expected to
receive from the book.

Microeconomics
- concerned with decision-making by individual economic agents such as firms and
consumers.

It that focuses on the choices made by individual decision-making units in the economy—typically
consumers and firms—and the impacts those choices have on individual markets.
Macroeconomics is the branch of economics that focuses on the impact of choices on the total,
or aggregate, level of economic activity. Why do tickets to the best concerts cost so much? How
does the threat of global warming affect real estate prices in coastal areas? Why do women end
up doing most of the housework? Why do senior citizens get discounts on public transit systems?
These questions are generally regarded as microeconomic because they focus on individual units
or markets in the economy.

It is also about how we choose to spend our time and money. There are quite a few options to
choose from: sleep, work, study, food, shelter, transportation, entertainment, recreation and so
forth. Because both time and income are limited we cannot do all things all the time. Many
choices are routine or are driven by necessity. You have to eat and you need a place to live. If
you have a job you have committed some of your time to work, or if you are a student some of
your time is committed to lectures and study. There is more flexibility in other choices. Critically,
microeconomics seeks to understand and explain how we make choices and how those choices
affect our behavior in the workplace, the marketplace, and society more generally.

Factors of Production

a. labor
b. capital
c. natural resources
Choices concerning what goods and services to produce are choices about an economy’s use
of itsfactors of production, the resources available to it for the production of goods and services.
The value, or satisfaction, that people derive from the goods and services they consume and the
activities they pursue is called utility. Ultimately, then, an economy’s factors of production create
utility; they serve the interests of people. The factors of production in an economy are its labor,

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 MT. CARMEL COLLEGE OF SAN FRANCISCO, INC.
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capital, and natural resources. Labor is the human effort that can be applied to the production
of goods and services. People who are employed or would like to be are considered part of the
labor available to the economy. Capital is a factor of production that has been produced for use
in the production of other goods and services. Office buildings, machinery, and tools are examples
capital. Natural resources are the resources of nature that can be used for the production of
goods and services.

Labor

The human effort that can be applied to production. People who work to repair tires, pilot
airplanes, teach children, or enforce laws are all part of the economy’s labor. People who would
like to work but have not found employment—who are unemployed—are also considered part of
the labor available to the economy. In some contexts, it is useful to distinguish two forms of labor.
The first is the human equivalent of a natural resource. It is the natural ability an untrained,
uneducated person brings to a particular production process. But most workers bring far more.
The skills a worker has as a result of education, training, or experience that can be used in
production are called human capital. Students who are attending a college or university are
acquiring human capital. Workers who are gaining skills experience or through training are
acquiring human capital. Children who are learning to read are acquiring human capital. The
amount of labor available to an economy can be increased in two ways. One is to increase the
total quantity of labor, either by increasing the number of people available to work or by
increasing the average number of hours of work per week. The other is to increase the amount of
human capital possessed by workers.

Capital

Long ago, when the first human beings walked the earth, they produced food by picking leaves
or fruit off a plant or by catching an animal and eating it. We know that very early on, however,
they began shaping stones into tools, apparently for use in butchering animals. Those tools were
the first capital because they were produced for use in producing other goods—food and
clothing. Modern versions of the first stone tools include saws, meat cleavers, hooks, and grinders;
all are used in butchering animals. Tools such as hammers, screwdrivers, and wrenches are also
capital. Transportation equipment, such as cars and trucks, is capital. Facilities such as roads,
bridges, ports, and airports are capital. Buildings, too, are capital; they help us to produce goods
and services.

Capital does not consist solely of physical objects. The score for a new symphony is capital
because it will be used to produce concerts. Computer software used by business firms or
government agencies to produce goods and services is capital.

Capital may thus include physical goods and intellectual discoveries. Any resource is capital if it
satisfies two criteria:

1. The resource must have been produced.

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 MT. CARMEL COLLEGE OF SAN FRANCISCO, INC.
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2. The resource can be used to produce other goods and services.

One thing that is not considered capital is money. A firm cannot use money directly to produce
other goods, so money does not satisfy the second criterion for capital. Firms can, however, use
money to acquire capital. Money is a form of financial capital. Financial capital includes money
and other “paper” assets (such as stocks and bonds) that represent claims on future payments.
These financial assets are not capital, but they can be used directly or indirectly to purchase
factors of production or goods and services.

Natural Resources

There are two essential characteristics of natural resources. The first is that they are found in
nature—that no human effort has been used to make or alter them. The second is that they can
be used for the production of goods and services. That requires knowledge; we must know how
to use the things we find in nature before they become resources.

Consider oil. Oil in the ground is a natural resource because it is found (not manufactured) and
can be used to produce goods and services. However, 250 years ago oil was a nuisance, not a
natural resource. Pennsylvania farmers in the eighteenth century who found oil oozing up through
their soil were dismayed, not delighted. No one knew what could be done with the oil. It was not
until the mid-nineteenth century that a method was found for refining oil into kerosene that could
be used to generate energy, transforming oil into a natural resource. Oil is now used to make all
sorts of things, including clothing, drugs, gasoline, and plastic. It became a natural resource
because people discovered and implemented a way to use it.

Defining something as a natural resource only if it can be used to produce goods and services
does not mean that a tree has value only for its wood or that a mountain has value only for its
minerals. If people gain utility from the existence of a beautiful wilderness area, then that
wilderness provides a service. The wilderness is thus a natural resource.

The natural resources available to us can be expanded in three ways. One is the discovery of new
natural resources, such as the discovery of a deposit of ore containing titanium. The second is the
discovery of new uses for resources, as happened when new techniques allowed oil to be put to
productive use or sand to be used in manufacturing computer chips. The third is the discovery of
new ways to extract natural resources in order to use them. New methods of discovering and
mapping oil deposits have increased the world’s supply of this important natural resource.

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